Present Value Of The Lease Payments example essay topic

Riverbend Telephone Company The Riverbend Telephone Company is experiencing growth and had previously tried outsourcing some of its installation work to handle the overflow above its capacity. This was unsatisfactory, and so to accommodate the new customers, RTC needs to obtain a new maintenance truck and crew. It is considering whether leasing or buying the new truck necessary to their operations is the preferable method of investment. Question 1& 2 Without considering financing the purchase through debt, the cash costs for buying the truck for years 0- 4 are: The cash costs for leasing the truck are: The cash flows discounted by the risk-free rate of 9% allows us to compare the present values.

This comparison illustrates a net advantage to buying the truck: There are not many advantages to leasing the vehicle, since Reliable does not cover the cost of maintenance or registration and taxes. They only cover the cost of tires, a minimal expense, which does not offset the cost advantages of buying the vehicle. The company does not seem concerned with their debt ratios or the threat of default. The main advantage to buying the vehicle, aside from the better price is the depreciation tax shield, which subtracts annual $1800 from the costs of ownership. There are tax advantages to leasing, as the lease payments are a tax deductible expense, but that tax savings amounts to $2,880/ year. However, this calculation is incomplete because the company needs to take on debt to finance the purchase of the car.

These payments add an additional expense and cash outflow but purchasing still remains a more attractive option. The cost of the lease is still greater than the cost of debt. The NAL still favors buying over leasing by $1216. The only other consideration would be that lease may raise the earnings on asset ratio above 12%. But since the PV of the lease payments is greater than 90% of the FMV (assuming the purchase prices is FMV), then it would be considered a capital lease and the asset would go on the Balance Sheet.

Therefore there are no earning over asset ratio advantages to leasing. Case Question 2 Using MARS, the tax benefit realized in the early years, still does not significantly affect the NAL. Overall the tax benefits at the end of the five years are still equal. (See calculations in spreadsheet). Case Question 3 If the truck is leased, how should Mr. Freeman report investment and annual income for the RTC to the state public service commission?

In reporting its rate of return on assets, as noted above, the present value of the lease payments is greater than 90% of the Fair Market Value (assuming the purchase prices is FMV), so it would be considered a capital lease and the asset would go on the Balance Sheet. Therefore, there are no earnings over asset ratio advantages to leasing, as the denominator (the net assets) is the same in both cases. The value of the truck should be included in the firm's net assets. It is not possible to determine whether this investment is above the firm's target 12% threshold, as there is no information about the returns generated by purchasing (or leasing) a truck.

The investment figure used to determine the rate of return on the lease of the truck should be the $38,148 NPV lease cost.